The Bankruptcy Reform Act:
What It Means to You

The Bankruptcy Abuse Prevention & Consumer Protection Act of 2005, commonly called the Bankruptcy Reform Act, is the first major change to bankruptcy law in decades. The idea behind it is to ensure that consumers are aware of all of their options for debt repayment before filing and, as the name of it suggests, reduce abuses of the bankruptcy system. Rules are more stringent than they have been in the past; so if you are contemplating filing, know how it works now.

Counseling Requirement

Before being able to file a bankruptcy petition with the court, you must first receive financial counseling from a credit counseling agency that has been approved by the U.S. Trustees office. This pre-filing counseling is your opportunity to review income, expenses, and debt obligations with a professional and objective counselor. The counseling covers debt repayment methods, money management, credit issues, and an overview of your rights and responsibilities as they pertain to debt.

After counseling, the agency will issue you a certificate that indicates that you’ve completed an approved counseling and education program. This certificate is required if you choose to go forward with filing bankruptcy.

To help consumers maintain a debt-free lifestyle, financial counseling is also required after bankruptcy discharge.

Means Test

If, after you’ve been through pre-filing counseling, you still want to pursue a Chapter 7 bankruptcy, you will then have to pass a “means test” to determine if you qualify. The test exists to find out if you have enough money to repay at least a portion of what you owe. Your petition to file Chapter 7 will probably be denied if, for six months before filing, you have income of $100 or more left over after paying your living expenses.

Determining if you pass the means test takes more than a simple “income minus expenses” calculation. Not only will the court consider your actual living expenses, but the Internal Revenue Service’s hypothetical expenses as well. These proposed expenses, based on local and national standards, might be considerably lower than what you truly spend. Allowable deductions include child support payments, the cost to care for ill or disabled family members, some annual school expenses, and certain payments to secured creditors.

If your combined household income is less than the median family income in your state (the amount varies, but is typically around $50,000), you will still have to pass the means test but your petition for Chapter 7 will likely be granted.

Bankruptcy Reform Act Provisions

• There is a nationwide cap of $125,000 on homestead exemptions (the amount of home equity you get to keep) for property acquired in the last three years.
• You will have to wait eight years before discharging debt in bankruptcy again.
• The automatic stay (which, upon filing for bankruptcy protection, legally suspends lawsuits, evictions, foreclosures, and collection activity) is weakened for multiple filers.
• If you financed a car within two and a half years of filing, or made any other major purchase within one year, the full balance must be paid to keep the item.
• To claim your state’s exemptions (the property you get to keep in a Chapter 7), you have to be a resident for at least 720 days.

Chapter 13 bankruptcy

If your petition to file a Chapter 7 is denied, you still have Chapter 13 bankruptcy as an available option.

Chapter 13 bankruptcy is a court supervised repayment plan where you pay at least a percentage of your debt over 36 to 60 months. Some of the rules for Chapter 13 are stricter than they used to be, and your financial activity during the repayment period will be under close scrutiny:

• Spending on such luxury items as expensive or multiple cars, jewelry, private school tuition, and vacations will likely have to be reduced or eliminated.
• To keep excess (typically, more than one) financed assets such as a car, boat, or electronics, you may have to pay the replacement value.
• Raises and bonuses received during the repayment period will probably be diverted to repay the debt.

Bankruptcy is a serious decision and should not be entered into without exploring all other options first. A bankruptcy notation on your credit record (particularly a Chapter 7) can negatively impact such future decisions as buying a home or car, renting an apartment, purchasing insurance, and securing employment. Before minor problems become major, obtain comprehensive financial counseling early.